Interest Rates Rising – the sequel

Mal Spooner is a veteran fund manager and currently teaches at the Humber College School of Business.
Mal Spooner is a veteran fund manager and currently teaches at the Humber College School of Business.

No doubt you’ve noticed about half the industry pundits cautioning that the US Federal Reserve is closer to ‘tightening’ monetary policy.  What this implies for us regular folk is that they will introduce monetary measures that will allow interest rates to rise.  We have enjoyed a very long period of inflation and interest rate stability following the financial crisis (a crisis almost forgotten by many).  Despite a recent slowdown in come economic indicators, efforts by governments around to world to jumpstart an economic recovery did bear some fruit.  The rebound in profitability, employment and growth has been particularly robust in the United States.  Both Europe and China are now making efforts to replicate this success by bolstering liquidity in their financial systems as the US did.

So what’s to worry about?  Savvy investors will have already noticed that interest rates in the world’s strongest economy have already begun to rise, even before the FED has taken any action.  This is what markets do – they anticipate rather than react.  Some forecasters predict that although interest rates are bound to trend upward eventually, there’s no need to panic just yet.  They suggest that there’s enough uncertainty (financial distress in Europe, fallout from falling energy prices, Russia’s military ambitions, slow growth in China) to postpone the threat of rising rates far into the future.

Yield Curves 2015-05-02_15-28-30

What they are ignoring is that the bond markets will anticipate the future, and indeed bond investors out there have already begun to create rising interest rates for longer term fixed-income securities.  The graph illustrates that U.S. yield curves have shifted upward.  The curve shows market yields for US Treasury bonds for various maturities back in February compared to rates more recently.  So what’s the issue?  If investors hang on to their bonds while rates are rising, the market value of those bonds declines.  This often comes as a surprise to people who own bonds to avoid risk.  But professional bond traders and portfolio managers are acutely aware of this phenomenon.  So they begin to sell their bonds (the longer term-to-maturity bonds pose the most risk of declining in value) in order to protect themselves against a future rise in the general level of interest rates.  More sellers than buyers of the bonds pushes down the market price of the bonds, which causes the yields on those same bonds to increase.

Many money managers (including me) have learned  that despite how dramatically the world seems to change, in many respects history does repeat itself.  For example, while writing my CFA exams back in the mid-1980’s, I was provided with sample exams for studying, but they were from the most recent years.  I figured it was unlikely that questions on these sample exams would be used again so soon, and managed to do some digging in order to find much older previous exams.  I reasoned there are only so many questions they could ask, and perhaps older exam questions might be recycled.  I was right! In fact several of the questions on the exam I finally wrote were exactly the same as the ones I’d studied from the old examination papers.

In my experience recent history is not useful at all when devising investment strategy or trying to anticipate the future, but often a consideration of historical events further back in time – especially if trends in important economic drivers are similar – can be very helpful indeed.

The consensus is that interest rates will rise eventually.  But it is human nature to stubbornly hang on to the status quo, and only reluctantly (and belatedly) make adjustments to change.  What if what’s in store for us looks like this:  Consistently increasing interest rates and inflation over the next decade?  This has happened many times before (see graph of rising 10-year Treasury bond yields from 1960-1970).

US Treasury Yields 1960 - 1970

Before you rant that things today are nothing like they were then (and I do agree for the most part) consider the following: Is the boy band One Direction so different today compared to The Monkeys then?  And wasn’t the Cold War simply Russia testing the fortitudes of Europe and America just like the country is doing today?  Weren’t nuclear capabilities (today it’s Iran and North Korea) always in the news?

Yes there have been quantum leaps in applied technology, brand new industry leaders in brand new industries.  China’s influence economically was a small fraction of what it is today.  So where is the commonality? The potential for rising interest rates coming out of a recession.  The US government began raising rates in 1959, which caused a recession that lasted about 10 months from 1960 – 1961.  From that point until 1969 the US economy did well despite rising interest rates and international crises.  But which asset classes did well in the environment?

Growth of $100 - 1960 to 1970

Could the disappointing 1st quarter economic data be hinting that we might also be entering a similar transitioning period?  Inflation is bad only for those unable to pass higher prices along to customers.  If the economy is strong and growing then real estate and stock markets provide better returns.  Since the cumulative rate of inflation between 1960 and 1970 was about 31%, investors essentially lost money in constant dollars (returns below the rate of price inflation) by being invested in the bond market.  They would have done better by simply rolling over short-term T-Bills.  An average house in the US cost about $12,700 in 1960 and by 1970 cost $23,450 – beating inflation handsomely.

Do I believe we will see a repeat of the 60’s in terms of financial developments?  Yes and no!  There will be important similarities – especially in terms of stock markets likely performing well enough and the poor prospects for the bond market. There will be differences too.  The outlook for real estate is clouded by the high level of indebtedness that has been encouraged by extremely depressed interest rates over the past few years.  Higher rates mean higher mortgage payments which might serve to put a lid on real estate pricing, or cause prices to fall significantly for a period of time before recovering.

Companies that have substantially financed their acquisition binges with low-cost debt will soon find that unless they can pass along inflation to their customers their profit margins will be squeezed.  Who will benefit?  Commodity producers have had to significantly reduce their indebtedness – commodity prices tend to stagnate when inflation is low, and even decline when economies are growing slowly.  In a global context, these companies have had a rough time of it.  It is quite possible that their fortunes are about to improve.  If Europe and China begin to enjoy a rebound then demand will grow and producers will have more pricing power – perhaps even enjoying price increases above the rate of inflation.

Do I believe any of this retrospection will prove useful?  I hope so.  The first signs that a different environment is emerging are usually evident pretty quickly.  If there were a zero chance of inflation creeping back then why are some key commodity prices showing signs of strength now?

recent aluminum price recent copper price data

If we begin to see inflationary pressures in the US before Europe and Asia, then the $US will depreciate relative to their currencies.  In other words, what might or might not be different this time is which countries benefit and which countries struggle. Globalization has indeed made the world economy much more difficult to come to grips with.  Nevertheless, there are some trends that seem to be recurring over the years.

There will be recessions and growth spurts.  In recessions and periods of slower growth, some formerly stronger industries and companies begin to lose steam as a paradigm shift takes place, but then other industries and companies gather momentum if the new reality is helping their cause.  This is why I’ve biased my own TFSA with commodity-biased mutual funds (resource industries, including energy) and a European tilt.  You guessed it – no bonds.

Any success I enjoyed while I was a money manager in terms of performance was because exercises like this one help me avoid following the mainstream (buying into things that have already done well) and identifying things that will do well.








Did Inter-generational Conflict subvert Swiss banking Secrecy?

Did Inter-generational Conflict subvert Swiss banking Secrecy
or was the desire to expose fraud the true motivator?

News Flash! Jan, 3, 2013

Wegelin Pleads Guilty in U.S. Case Over Secret Accounts/WSJ – Chyad Bray

– “In the latest blow to Switzerland’s centuries-old banking practices, the country’s oldest bank pleaded guilty to a criminal conspiracy charge in the U.S. on Thursday and admitted that it helped wealthy Americans for years avoid tens of millions of dollars in taxes by hiding their income from secret accounts abroad. Wegelin and Co., founded in 1741, is the latest Swiss bank to reach a deal with U.S. prosecutors as they crack down on Americans who kept their money in secret accounts overseas and the entities which helped them. (

Written by Ian R. Whiting, Consultant, and Gary Millar, Founder, Inter-Gen Consulting Group

When his doorbell rang that morning, Hervé Falciani could have never imagined how it would all turn out! Whatever his reasons for leaving Switzerland, it did not matter now. If he had left because he was mad at his treatment from his boomer bosses or motivated by his disgust at the obscene amounts hidden secretly in Swiss bank accounts, as he had seen in the bank records, or was he just a plain greedy thief? No one will ever know for sure? What is known is that he had left in a big hurry with HSBC banking customers’ private account details.

The door opened to a French Magistrate and Gendarmes, armed with an arrest order from the Swiss Government on charges of revealing banking secrets. An international arrest warrant was issued for Falciani, who is a citizen of Monaco with dual French and Italian citizenship. He is married with one child. Despite the fact his actions revealed thousands of cases of tax evasion all over Europe and some €10 billion (Euros) in lost taxes were recovered, Bern, Switzerland considers him a criminal, a thief. After explaining how he came to be named in the arrest warrant and revealing the data he had in his possession, the young Frenchman was subsequently offered life time housing, an annual pension for life and a new name, all for service to France!

It is from this point in the saga, the spin begins. In early 2009, an assistant prosecutor called for a search of Falciani’s family home. The routine operation became an unexpected gold-mine when information on approximately 130,000 accounts of alleged tax evaders was discovered. The prosecutor promptly opened an investigation, not aimed at Falciani but at the alleged tax evaders. The media learned of the investigation late in the summer of 2009.

How many people worldwide paid up or were forced to?
How much money was found by the governments?

The French Government announced that it had received a list of 3,000 holders of Swiss accounts but did not indicate the source of the data. The Government asked account holders’ to make themselves known to the tax authorities in order to legalize their situation. This prompted more than 4,000 people to come forward and France recouped about €1.2 billion in unpaid taxes.

In March of 2012, France announced it had recently launched inquiries on the basis of HSBC data allowing the Government to reclaim an additional €1 billion in unpaid taxes and penalties.

In the spring of 2010, the HSBC Spanish account holders’ information was passed on by France to the Spanish tax office and carefully reviewed. The Spanish officials asked suspected tax evaders to turn themselves in and to pay the taxes in addition to a fine. The amounts recovered in Spain based on the stolen HSBC information represents the most significant tax recovery in the history of the tax office. Allegedly, more than €6 billion was recovered. The list contained the names of many powerful people including the CEO of the Santander Bank.

On the Italian list sent by France, significant and well-known names appeared. That list contained nearly 7,000 people and included several fashion designers. By early fall of 2010, Italy completed most of their tax investigations and launched a tax amnesty aimed at luring dodgers to come clean by paying a very low penalty on their offshore accounts. As a result, a mind-blowing amount of €100 billion worth of accounts, were declared with two-thirds of that coming from Switzerland. It appears that the Italian tax authorities recovered close to €600 million in revenue based solely on the information passed along through Hervé Falciani.

On the morality of all of this, people have legitimate questions. Government and corporate morals are, at best, “flexible” and at worst subject to the greatest level of corruption imaginable and there is plenty of evidence to support either contention. The Wall Street Journal, the BBC and PressEurop have all written extensive articles on the fallout and twisted mystery surrounding one Hervé Falciani and one Georgina Mikhael – somewhere among the various webs and trails, lays the truth.

Should governments be relying on data that was obtained illegally – stolen or fraudulently obtained? Should governments be rewarding the people who stole the information in the first place? Or does the evasion of legitimate taxes owed justify the means used to collect them? What should be done about governments and countries that chose not to co-operate in matters relating to tax-fraud, money-laundering and the funding of terrorism and drug trafficking?

HSBC, UBS and other banks have recently paid huge fines in recent months of nearly US$5 billion as result of money laundering transactions that were ultimately revealed partially through tracing transactions in and out of these secret accounts.

In another case from 2012, Germany bought stolen Swiss account records from a bank employee. It isn’t known which banks’ records were acquired. Two years ago, Germany paid a €4.2 million (US$5.3 million) reward to another bank employee to buy stolen data from a Liechtenstein bank in order to chase more tax evaders.

As a result of these thefts and other “unauthorised” disclosures of information, US authorities accused UBS of having helped thousands of American taxpayers evade taxes by hiding money in secret Swiss accounts. After a lengthy and expensive legal battle, UBS agreed to turn over the names of nearly 4,500 US taxpayers to the IRS. This was done and hundreds of millions of dollars in tax revenue was recovered. In April of 2009, the OECD (Organisation for Economic Development and Co-operation) puts Switzerland on a “gray list” of uncooperative tax havens. A serious move indeed, this raised the specter of economic and banking access sanctions against the Alpine country. Subsequently, the Swiss government agreed to relax their bank secrecy laws.

The result: the Swiss Banking wall of secrecy has begun to crumble!

Did Hervé Falciani’s actions destroy the Swiss banking wall of secrecy? NO they did not. Swiss Legislative changes forced by OECD member-countries mean the Swiss banking system will co-operate with other governments when the Swiss receive “concrete evidence” of criminal activity, money-laundering, illegal tax evasion or fraud. Private numbered accounts can still exist as long as there is no illicit intent. However there are more than 130,000 people worldwide who have a different experience with their secret Swiss accounts being exposed to taxation as a result of Hervé Falciani’s actions.

So what has happened to Mr. Falciani as a result of his actions? Mr. Falciani could have stayed safely in France and lived out his life in government subsidized obscurity, under a different name; however he chose to attract attention to himself with interviews and travel to other countries. Subsequently he has been arrested in Spain, upon entry and is currently being held on an extradition warrant issued by Switzerland. The Swiss Government still considers him to be a thief and criminal.

What are the numbers involved?

The fines paid by HSBC, UBS and others may seem to be “get out of jail free” cards – none of the CEOs or other senior executives faced criminal charges and in fact, most are still running the same institutions and collecting large bonuses in the process.

If all of the numbers are to be believed, nearly 150,000 taxpayers around the world have been exposed or voluntary confessed the error of their ways. Recaptured taxes, penalties and fines have removed somewhere around €$12 billion from the economy – hopefully the beneficiary Governments use it to pay down some debt!

Truth be told, the fines are far too low – by a factor of at least 10. The $6 billion is just “chump change” and the “cost of doing business” for these large multi- and international financial firms. The fines certainly do not reflect the horrendous damage their actions have done to individuals and governments around the world to say nothing of the help given to terrorists and drug-traffickers. Virtually all of these recaptured taxes, penalties and fines can be traced back to the actions of one man.

What caused Hervé Falciani to steal confidential secret account records from HSBC Switzerland, after years of faithful service?

One of the points raised by the WSJ article may offer a clue. (Mr. Falciani said his goal was to expose security gaps at the bank, which he thought could harm clients and governments. Mr. Falciani says he alerted his bosses at HSBC in 2006 about flaws in data storage that could affect client confidentiality, but no one listened. HSBC officials said they found no such warnings by Mr. Falciani.)

Were the actions of Mr. Falciani triggered by his perception of unfair or biased treatment by his managers and senior executives at HSBC? On the surface, it would appear that Mr. Falciani was not on the best of terms with the management to whom he reported. The generational values of his bosses and their autocratic management style appeared to clash with his generational values. This resulted in a disconnection with the existing, long entrenched corporate culture of secrecy. It may be that this disconnect made it much easier for Mr. Falciani to cloak his theft with moral justifications. Whatever those moral justifications, he tried, together with his paramour, to get financial recognition from various countries before the French Gendarmes appeared at his door.

Inter-generational communication (and with it understanding), is key to keeping employees, associates and advisors happy in their roles. Each generation has widely varying personal needs and communications styles. Each generation employs very different means and language for communicating and building business relationships.

Education leads to understanding, understanding turns into knowledge, knowledge becomes empathy. Empathy creates lifelong inter-generational relationships.

It is important for each of us, at work, at play and with our families, to take the time to learn how to communicate across generations. This will reduce miscommunications, misunderstandings and increase appreciation of other generations.

With credit and appreciation to The Wall Street Journal, the BBC, PressEurop and Wikipedia for their work and materials they have published on this matter.

The Inter-Gen Consulting Group is a consulting organization which provides on-site presentations, recruiting and employment advice as well as on-line Inter-Generational Education courses. (

Latest Falciani update:
MADRID — The Spanish National Court on Tuesday granted conditional freedom to a former HSBC employee wanted by the Swiss authorities in the theft of secret data on tens of thousands of private bank accounts. Switzerland’s extradition request presented a dilemma for Spain, given that the Spanish authorities had used the HSBC data against holders of secret bank accounts.

Links to Story from Wall Street Journal:

In their describes which governments who have concluded tax treaties with Switzerland: Pressure Grows on Swiss Banks to Expose Tax Cheats’ Billions

Is it all over for stock market investors? Don’t bet on it!

I’ve been reading lots of articles suggesting that the stock market is ‘overbought’ (an expression meaning that we’re in some sort of a bubble, stocks are overvalued and risk is high that they’ll plummet) but then I’ve been reading the same thing over and over for a few years.  In fact I’ve been hearing the same thing ever since I suggested buying stocks while writing my book (A Maverick Investor’s Guidebook, Insomniac Press) back in 2010.  I’ve been a portfolio manager for a very long time, and find it fascinating that investors – even professional money managers – let their judgement be unduly influenced by their opinions which are biased by experience.  Experience is a funny thing.  For instance, the wife of a good friend of mine went to the trouble of working towards getting her motorcycle license.  Although she passed the test with little difficulty, she hopped on her husband’s bike to go for a ride, lost control and dropped the bike.  She never tried riding a bike ever again because of one bad experience.

Consider this quote from a smart friend of mine:

‘How much has your equity portfolio given on a yearly basis from January 1 , 2007 to today ( 6 years in 3 weeks. By bet is around 2%. You are doing some wishful thinking Mal.  The growth game is over.”

Why did she pick that particular date?  It’s probably not an accident.  Timing is everything when it comes to volatile assets and the stock market is nothing if not volatile.  Randomly chat with folks (like I do) and you’ll find some just can’t believe the stock market has made anyone any money…..EVER!  Talk to someone else and they might tell you they’ve been very happy with their experience.  Have a look at this graph:

If you’d invested your money (starting point) five or six years ago, you’d understandably be disappointed – see the red line.  If you’d decided to include stocks in your financial plan ten years ago (green line), it’s likely you’re satisfied and have no difficulty weathering a temporary storm.  An investor who read my book and put money to work coming out of the financial crisis (orange) will not only be ecstatic, he/she will no doubt have an exaggerated sense of their own investment ‘skills.’

In my estimation (which could be dead wrong) economic growth has only just begun to accelerate and I am not the only soul that believes it.  John Aitkens is an old friend and an excellent investment strategist at TD Securities.  These are his words (and his chart):

We continue to believe that global policy stimulus is driving a re-acceleration of US and global growth that will become increasing evident over the next few months. We therefore continue to recommend an overweight in stocks and an underweight in bonds. We recommend overweighting non-price sensitive cyclical areas (technology, industrials, consumer discretionary), while underweighting defensive sectors (utilities, telecom, consumer staples). We have financials, resources and health care at market weight.

Over many years John and I have been in agreement about the direction of markets…..i.e. he’s usually right.


Mal Spooner